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HUD’s small-dollar mortgage plan still hazy

Lenders typically avoid small-dollar mortgages because of higher origination and compliance costs relative to compensation

The Department of Housing and Urban Development said it is “looking very hard” at how to make it easier to finance small-dollar mortgages, but has yet to spell out how it will accomplish that goal.

In April, HUD signaled it would take on the issue. But a senior HUD official in mid-July stated the obstacles to providing small-dollar mortgages, instead of giving solutions.

“It’s hard to get lenders to make small mortgages, because quite honestly the economics of the whole business depends on percentages,” the HUD official said.

HUD did not respond to a request seeking clarity on their plan to boost small-dollar mortgages.

Industry practitioners have some ideas for how HUD might make financing such loans more feasible.

Small-dollar mortgages, typically with balances less than $200,000, are hard to find. Lenders avoid them, because originating a small-balance loan is as expensive as a larger loan, but the compensation, which is about 1% of the loan balance, is lower.

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Michael Loftin, CEO of Homewise, whose work revolves around sustainable homeownership, suggested HUD take a cue from the government-sponsored enterprises. Fannie Mae and Freddie Mac, although they rarely back small-dollar loans, subsidize lenders for originating them.

“Freddie Mac and Fannie Mae give [lenders] a little bump on their origination fee to encourage small-dollar lending,” said Loftin. “It’s an acknowledgement that you’re making less on a small-dollar loan.”

He added that non-traditional lenders, such as Community Development Financial Institutions (CDFI’s) and credit unions, should be key players in any plan by the federal government to make small-dollar mortgage loans more accessible.

“There are CDFI’s and credit unions that want to do this work, but maybe they need an operating subsidy or cheaper capital to make this work,” said Loftin. “Having a product alone will not address the problem — you still don’t have people doing the work on the ground.”

Loftin also suggested a subsidy for real estate agents, because “they can’t make a living selling $40,000 homes.”

A recent report from researchers at The Pew Charitable Trusts underscored the challenges of small-balance mortgage lending. The report found that fixed mortgage origination costs lead lenders to “focus on higher-balance loans.” Small mortgages are less profitable, because lender compensation is commission-based, but they come with the same regulatory and compliance risks, the researchers wrote.

Tara Roche, who co-authored the report, said that making small-dollar loans more accessible would help curb buyers’ reliance on riskier and costlier alternative financing.

Instead of mortgages, borrowers looking to finance more modest properties turn to land contracts, seller-financed mortgages, lease-purchase agreements, and personal property loans. That financing is often more expensive and lacks the consumer protections that come with mortgages, Roche said.

“In some arrangements, the deed or the title to the property isn’t handed over until much later in the transaction, sometimes not until final payment is made,” Roche said. Those borrowers “have the responsibilities of homeownership but not all of the benefits.”

The use of alternative financing is also not equitably distributed. Hispanic borrowers are almost twice as likely to use alternative financing than any other race or ethnicity, Pew researchers found.

Roche said that small-dollar lending is an overlooked area for mortgage lending, but that it has a lot of potential. Although it’s not yet clear how HUD will tackle the issue, Roche said she is encouraged that HUD is focused on the problem.

“In order to really get at the challenges in the smaller mortgage space, whether that’s lenders’ difficulty originating these profitably or the ability for buyers to access them, it’s going to take a multi-pronged effort,” said Roche. “HUD even identifying this as challenge is an important step.”

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